During difficult economic times
It is normal for the government to invest more than it earns. As a consequence, there is a deficit or debt. As a result, drastic budget cuts are implemented around the board, impacting the whole region. A loss like this happens as unemployment rises, causing a drop in the population's total income. Insufficient taxes would be collected if the tax burden remains on a phased basis rather than a fixed tax rate. As a result, in order to finance programs, the government chooses to borrow money (Gibbs, 2015).
The long-term consequence of investing borrowed funds
Is a fall in economic growth. It is this spending by the government when its budget cannot support its programs and projects that is termed as deficit spending. The deficit is financed by government actions such as the sale of securities such as treasury bills and bonds.
Advantages of Deficit Spending
One advantage derived from deficit spending is that it supports economic growth. The borrowing made by the government often creates investment opportunities to the lenders. Similarly, by accessing the desired funds, the government can spend on infrastructural developments while at the same time creating employment opportunities. As more investments are being made by the government all through a recession towards economic development, it will attract investors thus creating more jobs. With job creation, revenue is likely to increase, and economic development is maintained. Secondly, the government is often forced to govern its expenditure stringently. Given that it has to repay the borrowings made, wise spending decisions will be made while the projects undertaken will be closely monitored. The government is likely to seek projects with desirable value since the borrowed funds would be paid at a higher rate of interest. Thirdly, deficit spending protects the state during the periods of recession. Irrespective of the tough economic times, the country can finance its necessary and recurrent expenditures. Even in times of war, deficit spending will always chip in to provide funds that will be used in purchase military equipment while also sustain the armed forces.
Disadvantages of Deficit Spending
Despite the benefits of deficit spending, there also exists some drawbacks. Firstly, borrowing to finance expenditure can create a depraved economy. A country that is borrowing simply implies that it does not have sufficient savings. Moreover, as a result of debt financing, priority is given to repayment rather than savings. In case of emergencies, the country will have to borrow again and again either locally or internationally creating a cycle of borrowing. To repay these debts, tax hikes are likely to be implemented. Public spending is also likely to be cut down while commodity prices are likely to increase. This has a long term effect of the increase in the inflation rate thus downgrading the living standards. Another disadvantage is that borrowing reduces investments should the government fail to wisely and appropriately manage the debt. If the government fails to quickly sort the deficit, continuous borrowing will be experienced. This will eventually lead to a recession. Thirdly, if the government opts for international financing to bridge its deficit, the country's sovereignty will be in jeopardy. This is because the lending made are at a cost and often have particular demands with regards as to how the loan will be repaid.
The Crowding Out Effect
The term, 'crowding out' is used to imply to all the possible negative scenarios that can occur when debt financing is used to control a country's output. Crowding out' focuses on the multiplicity of avenues by which an expansionary fiscal strategy can end up having little, none or a negative effect on a country's output (Massachusetts Institute of Technology). The 'Ricardian equivalence' holds that changes in taxation patterns which do not affect government expenditure will not affect budget deficits. As a result, the economy and private investments will not be or will be altered a little (Massachusetts Institute of Technology). Fiscal Policies helps the economy to return to full employment whereby deficit spending ceases. The Ricardian equivalence and direct crowding out warns us that not any tax cut or spending increase will increase aggregate demand. However, deficit spending or income tax will increase the aggregate demand. At full crowding out periods of less than full employment, the amplified demand for money will eliminate zero or negative economic multipliers. It is also right to note that fiscal expansion influences capital accumulation and output undesirably during full employment.
Conclusion
Deficit spending can be noted as an accounting occurrence. Its possibility only depends on revenue shortfalls. The action is only taken by the government to maintain and improve the economic performance of the country. Despite the numerous advantages, the policy has disadvantages and as such can be viewed to be a short term solution to budgetary problems. As a fiscal policy, it helps protect the economy from adverse effects that result from the problem of employment. Through the crowding out effect, private spending, as well as tax rates, are monitored to foster the country's economic development.
References
Brown-Collier, E. K., & Collier, B. E. (1995). What Keynes really said about Deficit Spending. Journal of Post Keynesian Economics., 341-355. Retrieved September 7, 2017, from https://www.pragcap.com/wp-content/uploads/2015/06/keynes-and-deficits-collier.pdf
Gibbs, W. W. (2015, April 6). The Advantages of Deficit Spending Upon a Nation. Retrieved September 7, 2017, from https://whitneywelshgibbs.wordpress.com/2015/04/06/the-advantages-of-deficit-spending-upon-a-nation/
Massachusetts Institute of Technology. (n.d.). Crowding Out. Retrieved September 7, 2017, from https://economics.mit.edu/files/678
Smith, M. (2014, March 10). ‘Crowding out’ and the fallacy of fiscal austerity. Retrieved September 7, 2017, from http://theconversation.com/crowding-out-and-the-fallacy-of-fiscal-austerity-23981
